Great question! It depends – it’s hard having to use those words, “it depends,” but it really does. Deciding whether in invest your money or add to savings depends on your financial goals, risk tolerance, and time horizon.
Emergency Fund
Typically, it is always a good idea to consider having some money in savings and that it is accessible. The key behind this thinking is for emergency purposes. Below is a quick list of potential happenings that result in the need for you to get your hands on some cash:
- Car breaks down
- Spouse loses job
- A/C or HVAC goes out
- Monthly expenses are higher than income
- ER visits
- Ambulance rides
- Storm damage to vehicles or homes
- Escrow balance too low
- New tires for vehicle
- Birth of a baby
- Birthday gifts
- Christmas gifts
The list can go on and on. One thing that we know about life is it can get costly if you are not prepared. Typically for most of our clients, we recommend keeping around 6 months’ worth of expenses available at all times. If both spouses have stable jobs and income, then you could justify around 4 months’ worth. The key to savings is that it is there when you need it most. If you don’t have a good savings built up, the alternative is typically credit card debt, and that is something that is hard to swim out of.
Shorter-Term Financial Goals
Shorter-term financial goals are the next things to consider. This can be any major expenditure that you plan on doing in the next 12 to 24 months (about 1-2 years). Purchasing a vehicle, buying a home, traveling to Europe, taking 3 months off, etc. It is okay to include this money with your emergency savings, but typically we find success for those who open a separate account for only these funds. The goal would be to add to this bucket once you determine the amount you need to spend. For example, $15k for a trip to Europe in two years would be $625 per month being saved to reach this goal.
Investing Cash
Now we are ready to talk about investing. If there is a goal that is further out than 5 years it is generally okay to consider investing the money as an option, only if you believe that you have the risk tolerance to do so. There are plenty of vehicles that could earn moderate growth during this time period. This is because over a 5-year time horizon, you have a longer time to ride out any market volatility and potentially benefit from higher returns. Doing this in a diversified approach is important to help manage the risk associated with market volatility. If you have a large amount to invest you’ll want to consider dollar cost averaging vs lump sum.
If you have a longer time horizon like 10 years and can stomach market volatility, then you can be exposed to compound interest. Compound interest allows your investment returns to grow over time, as the interest earned on your initial investment is reinvested to generate even more returns. In other words, compound interest allows your investment returns to grow exponentially over time. The key to taking advantage of compound interest is to start investing as early as possible and to leave your money invested for as long as possible. This allows your investment returns to compound over time and helps you achieve your financial goals.
Invest Your Money or Add To Savings?
To wrap it all up, when deciding on how to manage your cash, it is important to consider your financial goals, risk tolerance and time horizon. Do you need the cushion of savings in an emergency fund? Or do you want to invest for longer-term growth? It is key that you make smart decisions during each stage of the process. Take some time to really think about what would most suit your individual circumstances or reach out to us. We’ll be happy to help you.
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